The relief effort "Orlando Cares-Help for Puerto Rico" held at the Orange County Convention Center helped box 4.4 Million Meals for shipment to Puerto Rico. Forster Boughman & Lefkowitz attorneys and their families volunteered their weekends to the cause.

An often overlooked, but essential component of asset-protection planning is making a careful assessment of a client’s financial status. Although timing is generally considered the most critical element of asset protection, due consideration must be given to both the value of assets exchanged and the effect of plan implementation on one’s balance sheet.

A fraudulent transfer claim is often the most effective weapon to disrupt an asset protection plan and reach assets transferred beyond a creditor’s grasp. Creditors can prove a fraudulent transfer by showing actual or constructive intent to hinder collection under the Uniform Fraudulent Transfer Act.1Actual intent involves a debtor’s state of mind and a subjective analysis of whether the debtor intended to avoid a claim.2 In the context of a lawsuit, proving actual intent is unpredictable because it generally involves trying to prove a defendant’s thoughts and intentions. By contrast, “constructive” intent generally involves an objective, two-part test. First, a debtor must have transferred assets in exchange for less than “reasonably equivalent value.”3 Additionally, the asset transfer must generally have left the debtor “insolvent” or undercapitalized to carry on business.4 Constructive intent, thus, generally involves an objective analysis of financial values. This objective analysis is often the most expeditious method of attacking a transfer as fraudulent.

A professional analysis of “reasonably equivalent value” and “solvency,” in connection with a protective transfer, can bolster and clarify asset-protection planning. The same financial analysis is integral to proving a constructive fraudulent transfer.

Reasonably Equivalent Value Determining whether the debtor received reasonably equivalent value for assets transferred essentially involves a value comparison of “what went out” versus “what was received.”5 Reasonably equivalent value does not necessarily mean equal value.6 It is often dependent on the circumstances.7 Timing could be a consideration. Property that must be quickly sold is likely to fetch far less than if listed, advertised, and marketed under regular market conditions.

Another consideration is the perspective from which value is determined. Creditors will argue that assets received by a debtor must be excluded from the solvency calculation to the extent exempt from creditor claims. A debtor may, for example, argue that receipt of protected limited liability company (LLC) equity constitutes reasonably equivalent value received in exchange for the transfer of exposed cash or other personal assets into the LLC; or that receipt of an interest in a protected financial account (such as an IRA) is an equivalent exchange for cash divested to the account. Although the law is unsettled, courts have suggested that the determination of whether the debtor received reasonably equivalent value should be made from the standpoint of the creditor.8 In a case arising in Florida, the 11th Circuit determined that transfers were not made for “reasonably equivalent value” when they drained assets that would otherwise have been available to creditors.9

Based on this interpretation, an ownership interest received by the debtor but not available to a creditor would not satisfy the act’s definition of equivalent value. Similarly, receipt of legally exempt or protected assets (in exchange for divested exposed assets) would not count “as reasonably equivalent value,” because the assets received would have no value from a creditor’s perspective. As an example, the conversion of cash from a personal checking account to a legally exempt IRA would not constitute an exchange for reasonably equivalent value in the fraudulent transfer context because the IRA is untouchable to the creditor. The contribution of cash into an LLC in exchange for an LLC membership interest is also not likely to be deemed reasonably equivalent value unless the interest is subject to foreclosure by a creditor.

Insolvency The second element of a constructive fraudulent transfer requires proof that a transfer rendered the debtor insolvent. A debtor is considered insolvent if the sum of his or her debts is greater than the fair value of his or her assets.10 This is generally referred to as “balance sheet” insolvency.11 The meaning of “fair value” in this context is not defined, but has been described as the sale of assets in a reasonable time at regular market value.12 Some parties may argue that assets should be valued according to generally accepted accounting principles (GAAP). Courts have ruled that GAAP may be potentially relevant, but is not controlling.13 The law requires that judges, not accountants, nor the board that promulgates GAAP, be the final arbiters of solvency.14 There are several legal considerations that veer from GAAP standards. For example, exempt assets are generally excluded from the calculation. Liabilities may be treated differently than in GAAP financial reporting. Valuations involving contingent assets and liabilities and disputed claims at the time of a transfer also warrant special consideration.

Value of Contingent Claims While the dollar value of contingent claims may be reasonably certain, the liability may never arise. Guarantees represent a classic example of contingent claims. Liability occurs only if the primary obligor fails to perform. In the solvency analysis (to determine if a transfer is constructively fraudulent), contingent claim values depend on the likelihood and timing of liability. The loan guarantee may be considered a greater liability if a default occurs (or is more likely to occur) tomorrow versus one year from tomorrow. Hindsight is generally not a factor in valuing contingent claims.

Under a “probability discount rule,” the “fair value” of a contingent liability “should be discounted according to the possibility of its ever becoming real.”15 In one case, a court gave the following example, where Company A, valued at $1.7 million, guaranteed a $28 million loan to Company B:

“Suppose that on the date the obligations were assumed there was a 1 percent chance that [Company A] would ever be called on to yield up its assets to creditors of [Company B]. Then the true measure of the liability created by these obligations on the date they were assumed would not be $28 million; it would be a paltry $17,000. For at worst [Company A] would have to yield up all of its assets (net of other liabilities), that is, $1.7 million, and the probability of this outcome is by assumption only 1 percent....”16

According to the court in Matter of Xonics Photochemical, Inc., 841 F.2d 198 (7th Cir. 1988), the proper value of the $28 million contingent claim was, arguably, not $28 million, but only $17,000. Alternatively, under the same assumptions, it might be reasonable to assign a $280,000 value to the contingent claim, based on a 1 percent chance of loan default. Either way, as this analysis suggests, valuation of a contingent claim is not an exact science.

Effect of Collateral Another issue affecting valuation of contingent claims is whether such claims are fully or partially secured (and the stability of the value of such security). The real estate crash of the mid-2000s made clear the issue of stability in the value of collateral. When mortgage loans went into default, many first-position lenders with an initial 70 to 80 percent loan to value (LTV) ratio, were left with partially unsecured loans after real estate values fell 50 percent or more. Many second- and third-position mortgagees were left with claims that were, for all practical purposes, entirely unsecured. In a strong market, real estate encumbered by first- and second-mortgage loans may have a neutral or positive effect on a balance sheet. The same loans may result in hefty liabilities, far in excess of the value of real estate to which they attach, in a depressed market.

This argument was raised successfully in BB&T v. Hamilton Greens, LLC, 2016 WL 3365270 (Bankr. S.D. Fla. 2016). Three months after a $3 million construction loan default, the bank sued the developer and the loan guarantors. Six months after the lawsuit was filed, one of the guarantors created an offshore trust into which he transferred most of his assets (nearly $1.7 million). After obtaining a $4.9 million judgment, the bank sought to invalidate the transfers to the trust as fraudulent transfers.

The defendant testified to several circumstances supporting his position that he had no reasonable expectation that he would owe any money to the bank arising from the development loan. The property securing the debt was (at the time of the loan) valued at $15 million, his co-guarantors had a combined net worth of over $100 million, and his co-guarantors had indemnified him from the claim and discharged his other contingent liabilities. Relying on these and other factors pertaining to the debtor’s intent, the court ruled (considering the minimal likelihood of liability at the time assets were transferred) that the transfers to the trust were not fraudulent transfers.17 The ruling supports the premise that a debt guaranty constitutes a personal liability (in the solvency calculation) only to the extent that the debt is unsecured at the time of the alleged fraudulent transfer.

Value of Disputed Claims Claims may be disputed as to liability, value, or both. Malpractice, personal injury, product liability, and environmental claims generally fall into this category. Disputed claims differ from contingent claims in that the latter are based on the occurrence of future events that may not occur.18

In In re Babcock & Wilcox Co., 274 B.R. 230, 262 (Bankr. E.D. La. 2002), a court was required to value future asbestos liabilities and noted that various methodologies would yield a wide range in results. Multiple variables, including exposure estimates, exposure intensity levels, causation, latency periods, product identification, etc., made the endeavor quite problematic. One of the more difficult tasks for the court was determining whether hindsight was appropriate since, after the fact, it was known that claims had apparently ripened at a much higher rate than predicted (and, thus, forced the debtor into bankruptcy). Ultimately, the court determined that hindsight was inappropriate and the court was left only to determine whether Babcock’s financial predictions were reasonable under the circumstances existing at the time they were made.19

Some courts have, however, considered subsequent events (such as claim rates, default rates, or the value at which an asset or liability is ultimately negotiated) in assessing whether a party’s valuation estimates were reasonable when made.20 Thus, in calculating insolvency, a court could consider future circumstances (unknown to the debtor at the time assets are transferred) as relevant for determining whether to accept a party’s own valuation estimates for disputed claims. One prudent approach (to diminish judicial hindsight) is to make clear the debtor’s reliance (as a condition to transfer) on a professional assessment of value.

Value of Assets The value of assets in the fraudulent transfer context may be different than under accounting or regulatory definitions.21

Values determined by GAAP, SEC rules, and IRS revenue procedures may be unreliable because tax and accounting values on a balance sheet often have little to do with fair value in legal terms. Book value of retail inventory may be subject to an upward adjustment in anticipation of selling at retail value. Assets such as preferred distributions, debt-equity conversion rights, and voting control may have substantially different book values than fair values. Assets may also be valued individually or packaged in groups based on business considerations. Also, traditional GAAP rules for the treatment of debt as equity, and vice versa, may not be relevant in determining whether they are truly debt or equity in fraudulent transfer analysis.22

In EBC I, Inc. v. America Online, Inc. (In re EBC I, Inc.), 380 B.R. 348, 358 (Bankr. D. Del. 2008), both parties in a fraudulent conveyance action cited IRS Revenue Procedure 77-12 to support their arguments valuing the inventory of a retail business (for solvency purposes). One question was whether to use book value for inventory or to make an upward adjustment, because the inventory was to be sold at retail prices. The court was not persuaded to follow the revenue procedure, noting “[r]evenue [p]rocedures, like [GAAP], to be unhelpful because the tax and accounting implications of how assets are listed on a company’s balance sheet often have little to do with what a willing buyer and willing seller would agree is the fair market value of those assets.”23

The fair value of a debtor’s business assets may depend upon whether a company is a “going concern or on its deathbed.”24 The assets of a going concern are more likely to be sold in a prudent manner with reasonable time constraints and, thus, equate to a deliberate and calculated fair-market value.25 Liquidation value, however, may be more appropriate for valuing assets of a desperate debtor on its financial “deathbed.”26

Other Considerations Additional issues to consider are the impact and cost of insurance on liabilities, rights against third-party indemnities and guarantors, and potential claims against third parties.

Ultimately, in deciding whether a debtor is solvent, a court should ask: What would a willing buyer pay for the debtor’s entire package of assets and liabilities (excluding creditor protected assets and exempt assets)? To this question, the court in In Re Tousa, Inc., 422 B.R. 783 (Bankr. S.D. Fla. 2009), answered that if the price is positive, the debtor may be solvent; if the price is negative, the debtor may be insolvent.27 Arriving at the result may involve as much art as science and will certainly require the expertise of a seasoned appraiser.

Conclusion Assessment of financial status is essential to avoid fraudulent transfer claims. Receipt of reasonable equivalent value and maintaining client solvency are as critical as the timing of transfers. Determination of those issues may be highly subjective. The rulings discussed above have set the stage for debtors to defend personal planning by relying on determinations of value and solvency. Careful consideration of these issues could mean the difference between preserving or destroying the efficacy of an asset protection plan.

4SeeFla. Stat. §726.105(1)(b)(1) and (2); UFTA §(4)(a)(i) and (ii); see also §726.106, which provides similar modes proving a fraudulent transfer (as to present, but not future, creditors).

5In re Vilsack, 356 B.R. 546, 553 (Bankr. S.D. Fla. 2006). All states have adopted some form of the UFTA (or its successor, the Uniform Voidable Transactions Act) and courts routinely look to other states and to analogous provisions under the Federal Bankruptcy Code to interpret provisions of the act. See ASARCO LLC v. Americas Mining Corp., 396 B.R. 278, n.49, citing Creditor’s Comm. of Jumer’s Castle Lodge, Inc. v. Jumer, 472 F.3d 943, 947 (7th Cir. 2007); In re W.R. Grace & Co., 281 B.R. 852, 857 (Bankr. D. Del. 2002) (stating the court could seek guidance from cases interpreting similarly worded statutes, like the Bankruptcy Code); see also In re Tower Envtl., Inc., 260 B.R. 213, 222 (Bankr. M.D. Fla. 1998) (noting that Florida UFTA statutes are similar in form and substance to their bankruptcy analogs and stating that it is, thus, “appropriate to analyze the similar provisions of the state statutes and [the Bankruptcy Code] contemporaneously”). As such, we look to multiple states and bankruptcy courts in attempting to predict how a particular court might interpret provisions under the Florida act.

Orlando, FL – Partner Eric Boughman of the Orlando-based law firm of Forster Boughman & Lefkowitz and his wife, Heather, are continuing their holiday tradition of helping Central Florida pets in need.

The annual tradition includes spending time making and delivering delicious gourmet Rum Balls as they raise money for a favorite local charity, Franklin’s Friends, a 501(c)(3) charitable organization whose mission is to support Central Florida animal welfare by fundraising for local nonprofit and government agencies that are dedicated to Shelter/Rescue, Spay/Neuter, or Community Education programs. “This is a cause very close to our hearts and something we have enjoyed doing each holiday season for several years,” said Boughman. As its popularity has grown, the event has raised over $15,000 for animal welfare. “The Boughman’s Rum Ball fundraiser epitomizes Franklin’s Friends – a grass roots, all volunteer, fundraising organization,” says Monisha Seth, President of Franklin’s Friends. Anyone can support the cause by visiting Franklin’s Friends’ website at (www.franklinsfriends.info) and click the link to the Holiday Rum Ball promotion. Two size options are available, depending upon the size of the donation; a 25-piece box in return for a donation of $50 or more; or a 9-piece box in return for a donation of $25 or more. The Law Firm of Forster Boughman & Lefkowitz (www.fbl-law.com) is sponsoring the charitable endeavor and is covering all costs related to production, packaging and shipment. Purchase a gift that is unique and delicious this year, where 100% of the proceeds go to a great cause!

The mission of Forster Boughman & Lefkowitz is to be “the gold standard for asset protection, corporate, estate, and tax planning and associated litigation.” The firm’s attorneys provide experienced counsel in the areas of international and domestic corporate, tax, asset protection and related litigation, through highly personalized service. The firm is an approachable and economic alternative to large national and international law firms. For more information, visit www.fbl-law.com or call 407-255-2055 or toll-free at (855) WP-GROUP. Se habla Espanol. Founded in 2003, Franklin’s Friends is an all volunteer 501(c)(3) nonprofit organization whose mission is to support Central Florida animal welfare by fundraising for local nonprofit and government agencies that are dedicated to Shelter/Rescue, Spay/Neuter, or Community Education projects. Franklin’s Friends is honored to have raised over $1,000,000 for local animal welfare. To learn more about Franklin’s Friends or support their fundraising mission please visit www.franklinsfriends.info.

Attorneys and their families from the Orlando-based law firm of Forster Boughman & Lefkowitz (www.fbl-law.com) volunteered their weekends to “Orlando Cares – Help for Puerto Rico” at the Orange County Convention Center.

“This is one of the largest humanitarian crises our nation has seen in fifty years. There is still so much we can do. We encourage other businesses and the community to support the effort,” said the firm’s Managing Partner, Gary A. Forster.

The assembly effort will continue seven days a week, 10 a.m. – 9 p.m. weekdays and 8 a.m. – 9 p.m. weekends through November 4, or until 4.4 million meals have been boxed and shipped from Orlando to Puerto Rico.

Jacob Engels is an Orlando based journalist whose work has been featured and republished in news outlets around the globe including Politico, InfoWars, MSNBC, Orlando Sentinel, New York Times, Daily Mail UK, Associated Press, People Magazine, ABC, and Fox News to name a few. Mr. Engels focuses on stories that other news outlets neglect or willingly hide to curry favor among the political and business special interests in the state of Florida.

Orlando, FL – Attorneys and their families from the Orlando-based law firm of Forster Boughman & Lefkowitz (www.fbl-law.com) volunteered their time this past weekend to “Orlando Cares – Help for Puerto Rico” at the Orange County Convention Center.

“This is one of the largest humanitarian crises our nation has seen in fifty years. There is still so much we can do. We encourage other businesses and the community to support the effort,” said the firm’s Managing Partner, Gary A. Forster.

The assembly effort will continue seven days a week, 10 a.m. – 9 p.m. weekdays and 8 a.m. – 9 p.m. weekends through November 4, or until 4.4 million meals have been boxed and shipped from Orlando to Puerto Rico.

Effective asset protection requires the strategic use of several legal components. These include the transfer of assets to protective structures (such as limited liability companies and trusts), proper allocation of legally protected assets, insurance and proper titling of assets to maximize legal exemptions from claims. Proper structuring insulates assets against claims from future, unknown creditors.

Timing is critical — this cannot be overstated. An effective plan must be implemented before clouds form. Existing and expected liabilities are not avoidable. Reactionary transfers — made to avoid liability — may be reversed and could entwine others in litigation, including recipients and professional advisers.

Take, for example, one client who owned and operated several successful franchises in Florida. Despite his financial success, animosity existed for several years between the franchisor and franchisee, culminating in non-renewal of the franchise agreements. A disagreement over termination and final accounting ultimately led to a lawsuit in the franchisor’s home state where the court entered a judgment against the client for over $1.6 million. Personal planning initiated prior to the lawsuit proved effective and the judgment was settled for less than 10 cents to the dollar.

How is this possible? For one, the client owned very few assets in his own name. He was married and most personal assets were properly titled to maximize the benefits of marital ownership. His several real estate holdings were generally owned in protective structures such as multimember LLCs with various partners, sometimes in a parent-subsidiary relationship.

Cash and other liquid assets were held in entities designed to make maximum use of business entity laws in the state of formation. Business operations were structured to make best use of income exemptions. The end result is that the client owned very little personal assets available to satisfy the judgment. Nothing was hidden from the creditor. In fact, settlement talks picked up steam after we disclosed the client’s organizational chart to the creditor’s attorney. With no exposed assets, the creditor’s recovery was limited to whatever the client was willing to offer to resolve the matter. Effective asset protection planning promotes favorable settlements.

Consider the result if the client had waited until the beginning of the lawsuit or after entry of the judgment to engage in asset protection planning. Most states’ laws permit creditors to reach otherwise protected assets which are the subject of a “fraudulent transfer.” These laws permit suit against both the debtor and the recipient of the transfer and empower creditors to reach assets intended to be transferred outside their grasp. Some states may even allow claims against third-party professionals involved in the transfer.

There have been cases in Florida, for example, where banks, financial advisers and lawyers have been sued in connection with a fraudulent transfer. Regardless of the end result, being named in a lawsuit is never a good thing.

In our case study, had the client waited until being sued to initiate planning, any protective transfers or re-titling of assets may have exposed the client and others involved to a separate fraudulent transfer lawsuit to unwind the transfer. Business partners, the client’s spouse, attorneys and any other professional advisers involved in the transfer also may have been dragged into the lawsuit.

Creditors can prove a fraudulent transfer by showing actual or constructive intent to hinder collection.

If a client seeks asset protection advice or involves a financial adviser in a potentially fraudulent transfer, the adviser must understand the limits and potential pitfalls. Asset protection involves several legal and financial components which, if not properly negotiated, can have potentially devastating legal ramifications. When a client seeks asset protection, always consider the implications of fraudulent transfers.

One advantage of purchasing a home in Florida is the homestead protection guaranteed by the Florida Constitution. Provided certain requirements relating to property features and ownership are satisfied, any principal residence in Florida is generally protected from forced sale without regard to value. Exceptions exist for the foreclosure of mortgages, construction liens, and tax liabilities but otherwise, whether a client owns a modest abode or a beachfront mansion, the equity is generally protected against creditors.

In the wake of the Great Recession, many people suffered severe losses and some continue to find themselves subject to creditors’ claims. Often, the first instinct is to try to “shelter assets” through transfers to family, friends, or protective structures such as retirement accounts or trusts. Like all states, however, Florida has “fraudulent transfer” laws that prohibit transfers to avoid creditors. Fraudulent transfers generally arise when an individual waits too long to engage in “asset protection.” To be effective, protective planning must be accomplished early — before claims arise.

One exception — and a salvation for debtors who haven’t properly implemented an asset protection plan — is the safe haven offered by Florida’s homestead protection. In the precedent-setting case of Havoco v. Hill, an out-of-state debtor being pursued by a creditor invested unprotected funds in a Florida home and claimed his intent to reside in Florida. The purchase appeared to represent a classic fraudulent transfer. Nevertheless, the Florida Supreme Court allowed the debtor to keep the home and established the principal that fraudulent transfer laws do not apply to homestead purchases.

Although it is more prudent to engage in asset protection before the need arises, for those who have not properly planned, Florida’s homestead protection offers shelter. The services of a REALTOR® in these situations can be crucial since any person subject to a judgment, whether or not a current Florida resident, can shelter liquid assets by purchasing and properly homesteading Florida property.

Article Written for : bizjournals.comAs the story goes, John D. Rockefeller was getting his shoes shined when the shoeshine boy, not knowing whose shoes he was shining, started offering stock tips.

That was Rockefeller’s cue to turn bearish on the stock market. "Secret" tips lose their efficacy when no longer secret.

While speaking at a recent seminar, we received several questions from CPAs and financial professionals about the use of Delaware bank accounts to protect cash. The questions reflect a national trend to use Delaware accounts for "asset protection."

Delaware law exempts banks and other financial institutions in Delaware from attachment and garnishment. Attempts by creditors to circumvent the law have been met with resistance in Delaware.

In a 1986 case (Delaware Trust Co. v. Partial), a judgment creditor who apparently understood that garnishment was prohibited against banks, tried to freeze a debtor's Delaware account by seeking a temporary restraining order prohibiting the bank from releasing funds. The court considered the order the functional equivalent of a garnishment and denied the request. The court explained that any order restricting the bank from releasing funds would violate Delaware’s "clear legislative policy exempting banks from garnishment."

For desperate debtors subject to a collection action, keeping cash in a Delaware account may offer some added protection; however, it should not be considered a substitute for well­conceived personal planning. Although Delaware banks are exempt from garnishment, nothing prevents a motivated and well­funded judgment creditor from issuing a subpoena to discover information regarding a debtor’s deposits (even knowing they can't be garnished).

A judge outside of Delaware, but with the debtor sitting in his court and intending to see a judgment enforced, may enter an order directed toward the debtor that practically eviscerates the effectiveness of the Delaware restriction. This is precisely what happened in one recent case in the Federal District Court in Orlando, Fla., last year.

In Travelers Casualty and Surety Company of America v Design Build Engineers & Contractors Corp. et al., a judge ordered a defendant with a well-­funded Delaware bank account (but, presumably, little other exposed assets) to post a cash bond with the court as collateral while a lawsuit was pending over certain indemnity agreements.

The facts of the case were the type likely to draw ire from the judge. Travelers sold a surety bond to Design Build Engineers and Contractors Corp., which subsequently got into a dispute over performance of two construction contracts insured by the bond. Travelers ultimately paid nearly $1.5 million to settle the two claims. Under certain indemnity agreements executed in connection with the bond, Design Build’s principals, Mr. and Mrs. Thompson, were required to deposit collateral with Travelers to cover the losses. When they failed to do so, Travelers sued. Then it got interesting.

Facing the lawsuit, the Thompsons formed several LLCs into which they transferred certain properties. Transfers of this type are the reason fraudulent transfer laws exist. Once transferred, two of the properties were sold for about $1 million and the proceeds were used to pay down the Thompsons’ Florida home mortgage. The Thompsons kept all the leftover cash in a Delaware bank account. Travelers sought an injunction requiring the Thompsons to post collateral as required by the indemnity agreements.

The Thompsons’ attorney made the right arguments. First, injunction is an extraordinary remedy intended to prevent irreparable harm that cannot be repaired with money damages. Though unpleasant, the mere loss of money can be remedied by a money judgment and is not recognized, in the legal context, as irreparable harm. Indeed, requiring a party to deposit money with the court would appear to be precisely the type of relief not permitted by an injunction. Additionally, the U.S. Supreme Court stated, in the 1999 case of Grupo Mexicana d Desarrollo S.A. v. Alliance Bond Fund, Inc., that unsecured creditors generally may not freeze assets prior to entry of a judgment. The Thompsons may also have argued that the court had no jurisdiction over the Delaware accounts and could not enter an order with respect to those accounts.

In any event, the court was not persuaded and ordered the Thompsons to post a collateral bond with the court amounting to nearly $1.5 million. In doing so, the court said, “While posting bond may be unpleasant to the Defendants, they will not be harmed by the requirement that they abide by the terms of their agreement.” The ruling stretches the boundaries of applicable law. Although Travelers was entitled to demand collateral under the contract, once the Thompsons failed to comply, the contract remained, on its face, an unsecured contract for money damages. A prejudgment injunction should not be used to magically transform an unsecured contract into one that is collateralized based solely on a claimed breach; otherwise, every contract for money damages may potentially be transformed into one where the posting of cash security is deemed to be fair and equitable relief.

The practical effect of the order places the Thompsons in a precarious position. They can rely on Delaware’s unique garnishment restriction (coupled with Florida’s constitutional homestead protection) to protect their home and cash from being taken directly; however, if they fail to voluntarily make those assets available as collateral, they risk being held in contempt of court. With contempt can come all sorts of horrible effects such as fines and incarceration.

The moral of this story is that reactionary transfers intended to desperately protect assets provide a platform for a court to order extreme remedies. As the Travelers court explained last year, the basis for the order was “supported by Defendant’s efforts to shield assets from Travelers’ lien claims by transferring assets to LLCs controlled by the Defendants.” Clearly, the court was not impressed with the Thompsons’ twelfth-­hour transfers.

Would the result have been different had the Thompsons engaged in the same protective transfers two years before the start of the lawsuit, instead of two weeks after? We think so. The effectiveness of asset protection planning is highly dependent upon timing. And, as the Travelers case shows, gambits such as reliance upon Delaware’s now ­popular banking statutes or Florida’s ultra ­protective homestead laws pale in protective comparison to well­ conceived protective planning.

The Uniform Voidable Transactions Act (UVTA) was recently adopted by the Uniform Law Commission (Commission) as the successor to the Uniform Fraudulent Transfer Act (UFTA). UFTA was itself an update of its predecessor, the Uniform Fraudulent Conveyance Act (UFCA). UFCA was revised to conform the Act to the Bankruptcy Reform Act of 1978. UVTA resolves several “narrowly-defined issues.” UVTA Prefatory Note 5 (2014).

The prevailing purposes for the UVTA amendments appear to be codification of a choice of law rule and to ameliorate divergent interpretations of the Act among the courts. The divergence has led to varying outcomes of similar claims under UFTA (which failed to create the uniformity desired). See UVTA. §4, cmt. 10 (2014). The changes also bring the uniform act into compliance with the UCC and Bankruptcy Code. UVTA offers some welcome clarity to an all too often misunderstood body of law.

The alterations to UFTA include a few definitional changes that modernize the Act. Updates also include a codified choice of law rule, an exception for UCC Article 9 security interests, the elimination of the separate insolvency definition for partnerships, clarity as to which party carries the burden of proof, and a defined evidentiary standard for seeking a remedy under the Act. Furthermore, the Commission updated and added comments to influence the application of UVTA, as adopted by the States. Some of the comments are worth noting, and (if adopted by the courts) the comments have the potential to change the avoidance analysis in some jurisdictions.

“Fraudulent” to “Voidable”

The most noticeable change made in the UVTA is the absence of the word fraudulent from the title and body of the act. In UFTA, “fraudulent” and “voidable” are used inconsistently to refer to transactions for which the act provided a remedy. UVTA replaces “fraudulent” with “voidable” to clear up the inconsistency. Another purpose of the change is to discourage the “oxymoronic usage” of the phrase “constructive fraud” and the misleading phrase “actual fraud”. UVTA §14, cmt. 1 (2014). The use of these phrases perpetuates the confusion and inconsistent application of the act among the courts. The prior language is also inappropriate because “constructive fraud” is confusing, and what is deemed actual fraud (under subsection 4(a)(1)), does not actually require proof of fraudulent intent. See UVTA, §4, cmt. 10 (2014).

Confusion caused some courts seeking collection to latch on to the word “fraudulent.” This led to applications of UFTA inconsistent with its original intent. Some courts applied and continue to apply higher (fraud) pleading standards, and higher evidentiary burdens. The application of a heightened pleading standard most commonly occurs in Bankruptcy Courts applying the Federal Rules of Civil Procedure. For instance in In re: Sharp Int’l Corp, the second circuit, in affirming a decision by a bankruptcy court, held that when

“actual intent to defraud creditors is proven, the conveyance will be set aside regardless of the adequacy of consideration given.” McCombs, 30 F.3d at 328. As “actual intent to hinder, delay, or defraud” constitutes fraud, Atlanta Shipping, 818 F.2d at 251, it must be pled with specificity, as required by Fed.R.Civ.P. 9(b). Moreover, “[t]he burden of proving ‘actual intent’ is on the party seeking to set aside the conveyance.” In re Sharp Int’l Corp., 043 f.3d 43, 56 (2d. Cir 2005) (citations omitted)

The court’s imposition of a heightened pleading standard reflects how the court confused the creditor’s remedy of avoidance with the elements of common-law fraud. A higher pleading standard improperly limits creditor claims.

The confusion has also led several courts to impose a higher evidentiary burden than was intended by the UFTA. The California Sixth District Court of Appeals held in Reddy v. Gonzalez that, to avoid a transfer, a creditor must prove the actual intent to hinder, delay, or defraud “by clear and convincing evidence.” Reddy v. Gonzales, 8 Cal. App 4th 118, 123 (1992); see also Parker v. Parker, 681 N.W.2d 735, 7432 (Neb. 2004) (court applied “clear and convincing” standard to the fraudulent transfer claim under the section of the Nebraska statute that correlates to UFTA section 4(a)(1)). The imposition of a higher standard hinders creditors who would otherwise have a valid claim of avoidance under the UFTA “preponderance of the evidence” standard.

The change in terminology itself is not designed to have any substantive impact. The Commission states in the preface that “[n]o change in meaning is intended”. UVTA, Prefatory Note (2014). However, the change seems motivated by the Commission’s desire to deter the misinterpretation of “shorthand tag[s]” “constructive fraud” and “actual fraud.” UVTA §4, cmt. 1 (2014). In addition, the change in terminology is aimed at reducing the confusion caused by the word “fraud” in applying UFTA. See U.V.T.A. §4, Comment 8. The Commission handled some of these issues directly and indirectly. They did so, by adding new subsections and amending and adding comments.

Defining the Party that Bears the Burden of Proof

The Commission took direct measures to correct the differing evidentiary standards, and burdens of proof. For example, some courts have applied the “clear and convincing” evidence standard to actions under UFTA subsection 4(a), instead of the “preponderance of the evidence” standard that was intended. The Commission added the subsections 2(b),4(c),5(c),8(g), and 8(h) which together create “uniform rules on burdens and standards of proof relating to the operation of the [UVTA].” UVTA §4, cmt. 10 (2014). If adopted by the states, these additions will create the intended uniformity in application. Adoption will also create more certainty for creditors (no longer subject to higher evidentiary standards in jurisdictions that adopt the UVTA). The following is an overview of such subsections.

Subsection 2(b) deals with the presumption of insolvency. It states:

“a debtor that is generally not paying the debtor’s debts as they become due, other than as a result of a bona fide dispute, is presumed to be insolvent. The presumption imposes on the party against which the presumption is directed the burden of proving that the nonexistence of insolvency is more probable than its existence”. (emphasis added) UVTA §2(b) (2014).

This subsection revises the UFTA in two ways. First, it clarifies that debts subject to “a bona fide dispute” are not to be considered when determining whether the debtor is failing to pay his debts as they become due. Id. Second, the statute places on the debtor the burden of rebutting the presumption of insolvency by proving the “nonexistence of insolvency is more probable than its existence.” Id.

The addition of the “bona fide debts” language is simply a matter of clarification, as this was “the intended meaning of the language before the…[UVTA]”. UVTA §2(b), cmt. 2 (2014). This also brings the definition of insolvent in subsection 2(b) in line with that of the Universal Commercial Code (UCC), and the Bankruptcy Code. Id.

UVTA subsection 4(c) is another new addition. It provides the evidentiary standard for a claim under section 4 “TRANSFER OR OBLIGATION VOIDABLE AS TO PRESENT OR FUTURE CREDITORS,” and defines the party that bears the burden of proof under the section. The significance is similar to that of subsection 2(b). The addition is designed to clarify the act and prevent disparate interpretations. In states that apply the evidentiary standard of “clear and convincing evidence”, adoption of this provision would change the evidentiary standard to “preponderance of the evidence” standard. UVTA §4(c) (2014). The effect, in those jurisdictions, would be to make it easier for creditors to proceed with claims for avoidance under UVTA section 4. In addition, it is likely that heightened pleading standards would no longer be applied in states that adopt the UVTA for claims under section 4.

UVTA subsection 5(c) provides the evidentiary standard and allocates the burden of proof for a claim under UVTA section 5 “TRANSFER OF OBLIGATION VOIDABLE AS TO PRESENT CREDITORS”. UVTA subsection 5(c) places the burden proof on the creditor, except to the extent the burden is limited by subsection 2(b) (which shifts the burden to the debtor to show they are not insolvent if a creditor has proven the debtor is not paying his debts as they become due). UVTA §5(c) (2014). Subsection 5(c) establishes the evidentiary standard as a preponderance of the evidence. Id. Defining which party bears the burden of proof is likely most significant when added to this section because judicial presumptions have been applied that shift the burden to the transferee to show section 5 is inapplicable. For example, in In Re M. Fabrikant & Sons, Inc., the bankruptcy court applying New York’s UFCA stated that New York law “presumes that the debtor who transfers property without fair consideration is insolvent, and the burden shifts to the transferee to rebut it.” In Re M. Fabrikant & Sons, Inc. 447 B.R. 170, 195 (2011). The addition of subsection 5(c), and its brethren should override judicial presumptions such as those in In Re M. Fabrikant & Sons, Inc.

Subsection §8(g) was added to the UVTA to establish the party with the burden of proving each subsection of section 8 “Defenses, Liability, and Protection of Transferee or Obligee.” The party asserting one of the following defenses bears the burden of proving its applicability:

That a transfer is not voidable under subsection 4(a)(1) because the transferee took in good faith and for reasonably equivalent value to the debtor;

A good faith transferee or oblige is entitled, to the extent of the value given to the debtor, to a lien or a right to retain an interest in the asset transferred, an enforcement of an obligation incurred, or a reduction in the amount of the judgment;

A transfer is not voidable by subsection 4(a)(2) or subsection 5 if the transfer results from the termination of a lease upon default by the debtor, or it is an enforcement of a security interest in compliance with article 9 of the UCC, except if the acceptance of the collateral is in full or partial satisfaction of the obligation it secures; or

A transfer is not voidable under subsection 5(b) to the extent (i) the insider gave new value to or for the benefit of the debtor after the transfer was made (except to the extent the new value was secured by a lien), (ii) it was made in the ordinary course of business of the debtor and the insider, or (iii) it was made pursuant to a good-faith attempt to rehabilitate the debtor and the transfer secured present value given for that purpose as well as an antecedent debt. UVTA 8 (2014).

Under section 8, a creditor carries the burden of proving that the transfer is avoidable under subsection 7(a)(1). UVTA §8(b) (2014). By proving a transfer is avoidable under subsection 7(a)(1), a creditor may recover the value of the asset transferred or the amount necessary to satisfy the creditor’s claims. UVTA §7(a) (2014).

Subsection 8(b) provides a defense to an avoidance action for an “immediate or mediate transferee of the first transferee” if they took in good faith and for value. UVTA §8(b)(1). Subsection 8(b) also provides a defense to a person who took in good faith that is a subsequent transferee of a person that took in good faith and for value. Id. A party raising either of these defenses carries the burden of proof. UVTA §8(g)(3). A party seeking adjustment to the value of the asset based “on the equities” of the transfer subject to avoidance has the burden of proving the equities. UVTA §8(c) (2014).

These subsections (like the other additions allocating the burden) are not designed to enact substantial change, but instead to clarify the law as originally intended by the UFTA. The defined burdens of proof will likely curb judicially crafted presumptions, and create more predictability when an action is brought under the UVTA. See UVTA, §4, cmt. 11 (2014).

The final addition to subsection 8(h), provides the evidentiary standard for all of section 8. UVTA §8(h) (2014). Consistent with the rest of the UVTA, it applies the “preponderance of the evidence” standard. Id.

Shifting the Focus from “Fraud” in Section 4(a)(1) Avoidance Actions

As stated above, the UVTA Commission was concerned about the misapplication of the act caused by the word “fraud”. The focus on “fraud” was primarily by courts applying the test under subsection 4(a)(1). Under subsection 4(a)(1), to determine if a transfer or obligation is avoidable, a court must determine whether the transfer or obligation was made with “actual intent to hinder, delay, or defraud a creditor.” UVTA §4(a)(1) (2014). Oftentimes the focus devolved to whether there was an “actual intent” to “defraud”. See General Electric Corp. v. Chuly Int’., LLC, 1, 4 (Fla. App. 2013), (“Because the determination of actual fraudulent intent can be difficult, courts look to certain ‘badges of fraud’ to determine whether the transfer was made with the intent to defraud creditors.”) (emphasis added). As noted, courts continue to confuse fraudulent transfer with common law fraud. The Commission sought to clarify how subsection 4(a)(1) should be applied, by the addition of a comment to section 4.

In the comment, the Commission emphasizes that the phrase “hinder, delay, or defraud” is a term of art. UVTA §4, cmt. 8 (2014). It should be applied as a whole, and not parsed out, nor should the focus solely be on “defraud.” The inquiry is not to be left to the subjective intent of the debtor. See In re Sentinel Management Group Inc., 728 F3d. 660 (7th Cir. 2013). Instead, whether a debtor is found to actually “hinder, delay, or defraud” a creditor depends upon whether “the transaction unacceptably contravenes norms of creditor’s rights”. UVTA §4, cmt. 8 (2014). Such norms are to be analyzed in light of “the devices legislators and courts have allowed debtors that may interfere with those rights.” Id.

This comment has the potential to properly recast the analysis courts conduct when weighing the so-called “badges of fraud” of subsection 4(b). The Comment appears to propose a test for determining whether there has been an attempt to “hinder, delay, or defraud”. The proposed test is whether the conduct “contravenes norms of creditor’s rights”, broadening the test which had devolved, in some cases, to whether the conduct was to defraud. UVTA §4, cmt. 8 (2014). In addition, emphasis on debtor conduct should minimize focus on the malicious intent of the debtor. The comment also cautions against avoiding transfers of legal means, such as transfers to a self-settled spendthrift trust which is permissible in some states. Such transfers should not be avoided in all cases because statutory authorization supplants what would otherwise almost always be an avoidable transfer.

Choice of Law

The driving force behind the revision of the UFTA appears to be the inclusion of a choice of law rule, which has the potential to eliminate much of the litigation in an avoidance action. The new choice of law rule is embodied in section 10 of the UVTA. The rule is similar to that of the UCC. See UVTA §10. Cmt 1 (2014). UVTA section 10 utilizes the debtor’s location to determine the local law that governs the avoidance action. UVTA §19)b) (2014). The test is the debtor’s location at the time of the transfer or incurrence of the obligation. Id. The debtor’s location is defined as:

The debtor’s principal residence if the debtor is an individual

The debtor’s place of business if the debtor is an organization and has one place of business, or

The debtor’s chief executive office if the debtor is an organization and has more than one place of business. UVTA 10(b) (2014).

The rule is simple, clear and easily applicable. The choice of law can have profound consequences. For instance, even among states that enacted the UFTA there are variations in the statute of limitations period, the treatment of an insider transfer, and the treatment of foreclosure sales and other involuntary transfers, among others. The choice of law rule does not alter these changes, and some are likely to persist. Instead, it affords creditors predictability as to which law will govern an avoidance action.

The significance of the rule is magnified when analyzing an example of a possible avoidable transfer. Absent a choice of law rule, it is difficult to determine which law will apply in the following scenario. A creditor located in California extends credit to a debtor individual residing in Florida. The debtor in Florida later transfers an asset located in Georgia to a charity transferee in Alabama with the intent to hinder, delay, or defraud the creditor. If the creditor were to try and avoid this transfer there would certainly be an argument over the applicable law.

If the court hearing this action determines that Florida law is applicable, the transferee may have a defense that the transfer is exempt from avoidance because Florida has a provision in its version of the UFTA which exempts some contributions to charity from avoidance. Fla. Stat. 726.109(7) (2013). The other three states California, Georgia, and Alabama do not have this exception. Assuming that the charity exception in Florida applies, the creditor would have a strong interest in trying to invoke the laws of one of the other jurisdictions with a connection to the transfer.

Under this scenario, a jurisdictions operating under the First Restatement of Conflict of Laws would apply the “situs” rule. The “situs” rule provides that the governing law is the law of the state where the asset was located, when it was transferred. This rule is rarely followed, and now most courts apply the Second Restatement to an avoidance of a transfer. The Second Restatement approach for Torts is to analyze the conflicting interests of the jurisdictions. The Second Restatement takes into account four different forms of contact, and seven different factors. The existence alone of a total of 11 variables (none of which is afforded any particular weight), determine which jurisdiction has the most interest in having its law be determinative in the dispute. Second Restatement, Conflict of Laws §145. This, by its very nature, is unpredictable and invariably leads to disparate results in different jurisdictions (or the same jurisdiction). Therefore, under the Second Restatement it is not possible to know which State’s law would be applied. If section 10 of the UVTA is applied, the answer is clear. The applicable law is Florida law.

The UVTA improves on both the Second Restatement and the First Restatement in two respects. First, it creates clarity for the creditor. The Second Restatement creates uncertainty for the creditor because it cannot be known before litigation which law will apply. This makes it more difficult for the creditor to gage the risk when extending credit. Second, section 10 of the UVTA does not appear to be as subject to abuse or manipulation (as is the “situs” rule of the First Restatement). An asset, particularly an intangible asset, or chattel, could be moved prior to the transfer to take advantage of more favorable fraudulent transfer law. Section 10 does a better job of preventing abuse by using more certain locations which are more difficult to manipulate.

Section 10 of the UVTA is not, however, immune to abuse. For example, an organization with multiple places of business could potentially manipulate the location of its chief executive office, or a business or resident could move prior to making the transfer. However, courts are able to look beyond the nominal place of residence, or chief executive office, and determine the true location based on activities of the debtor. UVTA §10, cmt. 3 (2014). The Commission states that a court should not fall suspect for an artificial location which has been achieved by manipulation. Instead the courts should look to “authentic and sustained activity”. Id.

Section 10 has the ability to diffuse disputes over the choice of law and give more certainty to creditors when extending credit. Note that it will, however, not alter the uncertainty of the choice of law in a Bankruptcy proceeding. In determining applicable state law, Bankruptcy Courts often take one of three approaches: (i) apply the choice of law created by federal common law, (ii) apply a uniform choice of law rule of the state in which they site, or (iii) apply the choice of law rule of the state in which they sit unless a federal interest requires the use of the federal choice of law rule. Section 10 cannot remedy this, as it is only applicable to state law (where adopted).

There were a few other minor changes to the UVTA. The first one, of some significance, is the alteration of subsection 8(e)(2) which exempts transfers from avoidance, if the transfer is made pursuant to the enforcement of a security interest made in compliance with UCC Article 9. The Commission added a new clause to subsection 8(e)(2). The new clause excludes from such exemption transfers made pursuant to an Article 9 security interest when the creditor accepts collateral for partial or full satisfaction of the obligation it secures. UVTA §8(e)(2). This means that §8(e)(2) no longer gives an exemption to strict foreclosures of Article 9 security interests. The significance is that creditors with an Article 9 security interest can no longer foreclose on the property and retain it, without risking the transfer being avoided. The creditor can, however, still conduct a foreclosure sale under Article 9 and be immunized from the transfer being avoided.

Under UFTA subsection 8(e)(2), there was no protection afforded other creditors from a creditor with an Article 9 security interest that foreclosed on an asset with built-in equity, and retained the asset. Remaining equity in the asset would have otherwise been available to settle other debts. Now, a creditor with an Article 9 security interest that forecloses may retain the asset, but be left subject to avoidance, or they must conduct a sale of the asset in a “good faith” and “commercially reasonable manner.” See UCC Art. 9 (2014). Both of these scenarios should protect the equity in the asset for other creditors.

Deletion of a the Separate Definition of Insolvency for a Partnership

Subsection 2(c) of the UFTA provides a separate definition for partnership insolvency. Insolvency of a partnership under this subsection is measured by determining if the sum of all of the partnership’s debts is greater than the aggregate of the partnership’s assets and the value of the general partners’ non-partnership assets to the extent they exceed the partners’ non-partnership debt. The Commission deleted UFTA subsection 2(c) to treat partnerships the same as other debtors. The deletion of this provision now treats partnerships the same as other debtors.

This deletion is significant because, when determining partnership insolvency, partnerships may not take into account assets to which the partnership may not have access. Modern business entity statutes permit partnerships to be formed where a (limited) general partner is not personally liable for all or even part of the partnership debts. Assets of general partners not liable for all partnership debts should not count in the solvency determination of the partnership (to prevent insolvency and avoidance of a transfer by the partnership).

The Commission found no reason to retain a rule that effectively gave special treatment to partnerships. See UVTA Prefatory Note (2014). The Commission viewed the liability of a general partner similar to that of a guarantor of a non-partnership debtor because both debts are guaranteed by contract. As a result, there did not seem to be any reason to define insolvency differently for a partnership debtor from that of a non-partnership debtor.

Series Organization

The UVTA adds a new section, section 11, which extends the application of fraudulent transfer law to series organizations and the series that comprise them. UVTA §11 (2014). The new section goes to great length to define a series organization, and a protected series. It defines a protected series as an arrangement by a series organization that has the same characteristics as a series organization. UVTA §11(a) (2014). A series organization is an organization that has the following characteristics:

An organic record of the organization which provides for the creation of one or more protected series with respect to specified property of the organization, and provides for records to be maintained for each protected series., the records of which identify the property of or associated with the protected series.

The debt incurred or existing with respect to the activities or property of a particular protected series is enforceable against only the property of or associated with the protected series, and not against other property of or associated with the organization or other protected series of the organization.

The debt incurred or existing with respect to the activities or property of the organization is only enforceable against the property of the organization and not against the property of or associated with a protected series of the organization.

The act treats each series organization, and each protected series of the organization, as a separate person, regardless of whether they would be treated as separate persons under other areas of the law. UVTA §11(b) (2014). The act extends to series organizations and protected series, “however denominated”, if they meet the characteristics set forth in the UVTA. Id.

This addition (segregating valuable assets between series, to potentially void such transfers and restrict avoidance of insolvency) may become quite significant, if adopted in states where series organizations (or Series LLCs) are permitted by statute. However, the UVTA arguably treats series as they would have been treated under the UFTA, since each series is ordinarily treated as a separate entity by statute. Nevertheless, the revisions ensure that transfers between series, or a series and the organization can be avoided.

Modernizing the UFTA

There are a few other changes made to UFTA which are of note, but likely have no practical significance. The first is the change in the title. The Commission approved the change of “transfer” to “transaction”. UVTA §14 (2014). The Commission made the change to make the title more inclusive. UVTA § 14, cmt. 1 (2014). “Transfer” ignored obligations which are also covered by avoidance law. Id. Second, the Commission took steps to modernize the UFTA, by adopting the terms “electronic” and “record” in place of writing. UVTA §1 (2014). These changes create medium neutrality by incorporating almost any mode of communication which more accurately reflects the manner in which business is conducted today. Third, the definition of “organization” was changed to conform to the UCCs definition; it is now separate from the definition of a person. See UVTA, §1 cmt. 10 (2014). An organization is now any person other than an individual. UVTA §1(10) (2014). The definition of “person” has been changed to remove the word “organization,” but is fundamentally the same. UVTA §1(11) (2014).

Summary

UVTA made several improvements to the UFTA. Some of the changes are more significant than others. The inclusion of a choice of law rule at section 10 will limit litigation and likely create a more stable lending environment. The removal of the exclusion from avoidance for Article 9 strict foreclosures also provides needed clarity. The clarification of burdens of proof and evidentiary standards will reduce the improper imposition of common-law fraud standards in avoidance actions. The change of “fraudulent” to “voidable” will also reduce confusion among the courts when applying the UFTA/UVTA. The other minor changes to the language of the UFTA modernize the Act and bring it in line with other uniform laws and the Bankruptcy Code. Overall, the changes are a positive step.

Article written for: Accounting TodayLimited liability companies have become the entity of choice for small business owners and are commonly utilized by professionals in asset protection planning.Choosing to use the LLC over (for example) a corporation may be prudent but raises the question of where to form the LLC. There are several factors to consider in deciding where to establish the entity. Picking the right LLC jurisdiction may be as important as the decision to use an LLC.

In 2010, the Florida Supreme Court issued a ruling that eviscerated the effectiveness of the Florida single­member LLC for asset protection purposes. In Olmstead v. FTC, the Florida Court, using judicial acrobatics, ruled that a judgment creditor may foreclose the LLC membership interest of the debtor. Although the writing was already on the wall—after all, other court decisions had previously called into question the wealth protection effectiveness of the single­member LLC—the Olmstead decision sent many Florida planners scrambling for safety in other states.

States such as Nevada, Alaska and Wyoming provide express statutory language respecting the protection of single­member LLCs. Wyoming became a particular favorite because of its low cost and the fact that LLC members and managers were not required to be publicly disclosed. A recent decision by the Supreme Court of Wyoming, however, should give planners cause for concern.

In Greenhunter Energy, Inc. v. Western Ecosystems Technology, Inc., the Wyoming Supreme Court last year upheld a ruling that permitted the creditor of a corporation's wholly owned subsidiary to “pierce the corporate veil” of the subsidiary, making the parent company responsible for the debts of its subsidiary.

Veil piercing is an extraordinary remedy typically reserved for those cases involving fraudulent conduct. The remedy is rarely permitted unless a limited liability entity is found to be the mere “alter ego” of its owner such that it would be inequitable not to make the owner responsible for subsidiary's debts.

In Greenhunter, the Wyoming Supreme Court acknowledged that the two companies (parent and subsidiary) maintained separate bank accounts and business records. The court, however, took the unprecedented step of considering consolidated tax returns as a factor favoring the alter ego relationship and permitted the plaintiff to pierce the subsidiary (to reach the parent's assets).IRS rules allow for a single­member LLC to be taxed as a disregarded entity. Indeed, the principal advantage of single­member LLCs has been their recognition as offering greater limited liability benefits than a corporation, coupled with “disregarded” tax treatment (avoiding the need for a tax return).

The Wyoming Supreme Court’s decision to confound tax treatment with legal liability is unprecedented and runs counter to proper application of LLC protections. This is a dangerous and surprising prospect from a state otherwise offering one of the most protective LLC statutes in the country.

Other factors should be considered as well. If stability is a concern, Delaware is a traditional choice and Nevada offers a sound alternative due to its reliance on Delaware’s longstanding body of favorable corporate law. If privacy is a concern, Delaware and Alaska are options. If the entity is to be owned by a single member and charging order protection is a concern, Nevada and Alaska offer a sound legal framework. If maximum asset protection is desired, the best options are often offshore.

And, finally, one should always consider the types of assets to be owned by the LLC. It makes little sense, for instance, to use a Delaware LLC to house Florida real estate for asset protection. The practical reality is that any litigation involving the property is likely to occur in Florida, where a Florida court could be expected to apply Florida law.

Entity selection is a fluid process. As reflected by the recent Wyoming decision, the Supreme Court of a favored state can quickly throw the state's law into a tailspin. Professional planning requires constant study and an awareness of legal trends and pitfalls.